India is currently facing a range of challenges from slowing economic growth and corruption scandals, to ethnic strife and political gridlock. Last week, in a surprising move, the Congress-led United Progressive Alliance (UPA) government announced bold new economic reforms that have the potential to get its economy back on track.

In a Q&A, Milan Vaishnav provides an overview of recent developments, and argues that the changes are merely the first step of a longer reform process which continues to face significant political opposition. 

What reforms were announced by the government?

Milan Vaishnav
Vaishnav’s primary research focus is the political economy of India, and he examines issues such as corruption and governance, state capacity, distributive politics, and electoral behavior.
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The government first announced an increase in the price of diesel, which is heavily subsidized. These subsidies have contributed to India’s large and growing fiscal deficits. This announcement was followed a day later by a declaration that the government would embark on a series of politically contentious reforms—with opposition mainly focused against increasing openness to greater foreign investment. 

The announcement that received the most attention is the government’s plans to allow up to 51 percent foreign direct investment (FDI) in multi-brand retail, or supermarkets. This will pave the way for global giants such as Walmart and Tesco to ramp up their operations in India. The government also announced that it would allow 49 percent FDI in civil aviation, 49 percent in electric power exchanges, and 74 percent in broadcast services. To top it off, the government signaled its intention to reduce its stake in several state-owned enterprises dealing with petroleum, aluminum, copper, and other minerals.

With respect to reform of the retail environment, the government’s decision gives individual states discretion to reject FDI—setting the stage for experimentation among the states in India’s federal system. The government will also place important constraints on any new investment, such as limiting FDI to cities with a population of 1 million or more, and insisting that retailers source at least 30 percent of their products from within India. 

How significant are these reforms?

The UPA government, beginning with Prime Minister Manmohan Singh, deserves credit for announcing these economic reforms. This government’s tenure (beginning with its reelection in 2009) has been extremely turbulent, and there was a growing feeling that it was rudderless and completely paralyzed. There is broad consensus that India’s economic problems are largely self-inflicted and that they have political roots, as argued for example by Pratap Bhanu Mehta in Foreign Affairs.

For instance, the government has struggled with managing complex coalition politics. While it has the votes to push through its agenda in theory, many of its coalition partners have been reluctant to act in practice. The fear of alienating its partners and precipitating early elections has caused the Congress-led government to move haltingly on its economic reform agenda. Last week’s reform announcement is therefore a calculated political risk. To quote Manmohan Singh: “The time for big-bang reforms has come, and if we go down, we will go down fighting.” This reform package helps right the ship and provides the government with newfound momentum.

Having said that, there is a danger of over-hyping these reforms. By and large, the current reform package is significant more in its symbolism than in its substance. The reforms will have a modest direct effect on growth in the near term, but they could have a significant, salutary indirect effect on growth by restoring business confidence, reassuring skittish foreign investors who were increasingly despairing about the future of the Indian economy, and bolstering the legitimacy and credibility of the ruling government.

The reforms that were announced represent low-hanging fruit. They can be implemented by fiat and do not require legislative action. Many of the ideas have been under discussion for years and, in the case of FDI in multi-brand retail, have even previously been announced (before being scuttled due to political pressure). Their introduction will also raise expectations about follow-on reforms, most of which will require legislative action and involve reforming India’s outdated regulatory, administrative, and legal machinery. In that sense, if this latest tranche of reforms are not used as a springboard, the economic “revival” could be short-lived. Indeed, the prime minister himself warned of the disastrous consequences of continued “policy logjam” for future growth.

In sum, the reforms are an important step in the right direction, but they are merely a first step. They are by no means a panacea for India’s ongoing economic troubles.

How strong is India’s economy currently?

In the quarter ending June 2012, India’s economy registered GDP growth of 5.5 percent, a slight increase from 5.3 percent in the previous quarter. In the United States, such robust growth rates are only possible in dreams. In India, however, this pace of growth is a sign of a significant economic downturn. 

Just last year, India was growing at around 8 percent. In order to create jobs for India’s growing working-age population and to continue lifting people out of poverty, most economists believe India will need at least 7-8 percent growth for the foreseeable future. In addition to the anemic growth figures, other leading economic indicators also are a cause for concern. Inflation, which has come down in recent months, remains stubbornly high and is projected to increase in the coming months. Over the past year, the Indian rupee has declined by about 20 percent against the U.S. dollar. The country’s fiscal and current account deficits are widening, tying the government’s hands even further.

In June the global ratings agency Standard & Poor’s warned that India’s sluggish economy could prompt a credit downgrade, which would mean Indian bonds losing their investment grade credit rating. Such a move would be a big blow to the economic outlook.

What is behind the recent corruption scandal plaguing the government involving coal?

The proximate issue behind the scandal, which is being referred to as “Coal-gate,” is the release of a new report by the Comptroller and Auditor General (CAG), which accuses the government of allocating around 60 coal blocks to private firms on a discretionary, ad hoc basis without competitive bidding or auctions. The CAG has estimated that this policy has resulted in losses to the exchequer to the tune of $33 billion. While the CAG’s numbers are fuzzy and the financial implications difficult to calculate, there is no doubt that the government has missed out on revenue under the current policy. 

The primary opposition party, the Bharatiya Janata Party (BJP), has seized on this report (as well as a host of recent scathing CAG reports alleging corruption) to bring parliament to a standstill. The BJP has vowed to obstruct parliament from conducting business until the prime minister resigns. The BJP does not want a parliamentary debate for three reasons. 

First, it has calculated that the theatrics of holding parliament hostage will result in a greater payoff than allowing for a parliamentary discussion of the matter since doing so allows it to keep the corruption allegations in public view. Once the matter is referred to a parliamentary committee, the concern is that the public might lose interest. Second, the BJP understands that the policy of not auctioning coal blocks predates the current government and so implicates the previous BJP-led central government. Finally, a great number of disputed coal blocks are concentrated in a handful of states which the BJP controls. Indeed, the government has released letters from BJP state chief ministers and other senior officials sent to the central government urging against a transition to a competitive allocation process with respect to coal.

Is corruption related to coal a symptom of a larger dynamic?

The deeper issue is how the government manages the allocation of India’s natural resources and the benefits stemming from their exploitation. “Coal-gate” is the latest in a long line of scams involving the government’s discretionary allocation of resources such as land, oil and gas, and mining to favored private sector entities. 

When the Indian government embarked on transformational economic reforms in the early 1990s, its proponents were focused on getting the government out of the way and harnessing the energies of the private sector. These reforms involved industrial delicensing, tariff liberalization, and increasing private sector competition in the economy. The issue of how best to manage the country’s natural resources was not addressed. 

As former IMF chief economist (and current economic advisor to the prime minister) Raghuram Rajan has previously noted, this meant that India transitioned from a policy framework governed by the “License Raj” to one dominated by the “Resource Raj.” In other words, the potential for corruption did not disappear; it merely shifted from one set of activities to another. 

Reforms that would rationalize the government’s heavy hand on issues of land and mining were viewed as “second generation” reforms, but the problem was that some of the winners emerging from the first generation of reforms had an interest in blocking subsequent reforms. These winners, and their political allies, have been able to exploit the often arbitrary, opaque, and regulatory-intensive governance of natural resources to make huge sums of money. 

Was the Indian blackout related to the coal scandal?

The two are somewhat connected. The root cause of the blackout was, at its most basic, an issue of demand outstripping supply. India has a growing appetite for energy, but the sector is plagued by enormous inefficiencies which have resulted in an enduring supply-demand mismatch. The disputed coal blocks in question involve “captive mines”—mines granted to the private sector to generate energy for their own activities. So if a firm operates a power plant, it could try and obtain a license to engage in coal mining for the purpose of powering that plant. This policy was put in place as recognition of the fact that the state-owned monopoly, Coal India, was unable to meet the economy’s growing demand for coal.

In addition to corruption scandals, India has also been hit by an outburst of ethnic violence. What have been the causes?

In August, violence broke out in the northeastern state of Assam between a local tribal group known as the Bodos and Muslim residents. Dozens were killed and more than 300,000 people were displaced in a region long known for instability. This violence led to protests by Muslims in Mumbai and other cities which also turned violent. The opposition BJP blamed illegal Bangladeshi (Muslim) migrants for fomenting discontent in Assam which resulted in the deadly clashes. A number of commentators—including several from the northeast—have disputed this claim, arguing instead that the conflict is a localized one between ethnic Bodos and Bengali-speaking Muslims (who have resided for years if not decades in the districts in question) over land and local political power.

After the breakout of violence, rumors began to circulate through text messages on mobile phones in southern India warning of reprisal attacks against northeasterners, many of whom have migrated to rapidly growing southern Indian “mega”-cities such as Bangalore in the search for employment. This sparked a panic and the mass exodus of northeasterners, overwhelming local authorities and the Indian rail system, the primary method of transport. The panic is now largely over and, for the time being, people from the northeast have returned to their homes in south India. 

Has the economic downturn caused this recent violence?

There is no evidence yet to support such a claim. It is important to underscore the fact that the outbreak of violence was relatively contained. It could be that the economic downturn is introducing new pressures which increase the potential for violence—as jobs grow scarce, for instance—but the data to evaluate this claim is lacking. 

What is clear, however, is that violence in India has steadily declined over the past four decades. As Devesh Kapur of the University of Pennsylvania has shown, with the exception of Maoist (Naxalite) violence, all other forms of violence—communal violence and insurgent violence in the northeast and in the contested areas of Jammu and Kashmir—have dramatically decreased. Even the murder rate, a measure of more conventional crime, has dropped significantly. Public order, in many ways, has actually been something of a bright spot for India in recent years. 

How do recent events affect the political outlook of the current government?

The government was smart to announce reforms after the most recent session of parliament came to a close. It is clearly hoping that things will blow over by the time parliament reconvenes. Yet, at some point, the government will have to find a way to get parliament to act on its reform priorities—and this is where things get sticky.

Although parliamentary elections are not due until 2014, there are a host of critical state elections starting in December and then continuing throughout next year. This means that the policy window for reforms that require legislative action is shrinking rapidly. The government is unlikely to muster much support for its agenda from its principal opposition, the BJP. The forthcoming elections in nearly all of the big states—Gujarat, Himachal Pradesh, Madhya Pradesh, Rajasthan, Chhattisgarh, Delhi—are bipolar contests between Congress and the BJP. It is therefore unlikely that the BJP will want to hand the Congress a major legislative victory heading into these elections. 

What will be more decisive is whether the Congress can hold its own coalition together. A key ally, the Trinamool Congress (TMC), has already warned the Congress leadership of negative “consequences” if the government does not roll back some of the most contentious reforms it announced last week. If the TMC leaves the coalition, it could still provide “outside support” to the government—which would forestall early elections. If it abandons the government altogether, then the Congress is likely to turn to the Samajwadi Party (SP), which is currently the ruling party in Uttar Pradesh, for support. The SP currently provides outside support but could play a larger role. However, the SP has indicated its opposition to greater FDI in multi-brand retail, and also has expressed its interest in seeing a non-Congress, non-BJP “Third Front” government after the 2014 elections. Past pronouncements should though be taken with a grain of salt. Government has an allure, as well as a number of tools it can use to sweeten the deal, and this makes a grand bargain of some fashion likely.